Tax Liability Debate: Tribunal’s Decision Overturned in Favor of Assessee

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Case Name:

Carbon and Chemicals (India) Ltd. Vs. Commissioner of Income Tax (High Court of Kerala)

ITR. No.70 of 2000

Date: 1st March 2021

Key Takeaways:

• The court emphasized that only the actual amount obtained by the assessee should be taxed under Section 41(1), not the gross amount including tax and interest.
• The decision highlights the importance of interpreting legal fictions within their intended scope and not extending them beyond their purpose.
• The ruling clarifies that issues involving debatable questions cannot be summarily adjusted under Section 143(1)(a).

Issue

The central legal question was whether the entire amount of Rs.53,71,650/- should be treated as income under Section 41(1) of the Income Tax Act, or if only the net amount of Rs.30,68,152/- should be considered, excluding tax and interest already paid.

Facts

• In the assessment year 1990-91, the assessee claimed a deduction for a royalty payable to a foreign collaborator, which was not remitted outside India.
• The assessee paid Rs.23,03,498/- towards tax and interest on this amount.
• In 1995-96, the liability ceased, and the assessee wrote back Rs.30,68,152/- instead of the full Rs.53,71,650/-.
• The Assessing Officer treated the entire amount as income, but the First Appellate Authority found this to be a debatable issue and allowed the appeal.

Arguments

• Assessee’s Argument: The profits chargeable to tax should be the net amount after deducting tax and interest, as taxing the gross amount would lead to double taxation and hardship.
• Department’s Argument: The entire amount should be taxed as income under Section 41(1), as income tax is levied on the amount received without deductions.

Key Legal Precedents

• CIT v. Haryana Co-operative Sugar Mills Ltd. and Polyflex (India) Pvt. Ltd. v. CIT were cited to support the interpretation of Section 41(1) as a deeming provision for taxing recouped amounts as income.
• The court also referenced the decision in British Mexican Petroleum Co. Ltd. v. Jackson to explain the purpose of Section 41(1) in overcoming previous legal challenges.

Judgement

The court ruled in favor of the assessee, stating that only the actual amount obtained should be taxed under Section 41(1), excluding the tax and interest paid. The court found the issue to be debatable, supporting the First Appellate Authority’s decision and overturning the Tribunal’s ruling.

FAQs

Q1: What does this decision mean for the assessee?

A1: The assessee is only required to pay tax on the net amount of Rs. 30,68,152/-, not the gross amount, reducing their tax liability.

Q2: Why was the issue considered debatable?

A2: The interpretation of whether the net or gross amount should be taxed under Section 41(1) involved complex legal analysis, making it a debatable issue not suitable for summary adjustment.

Q3: How does this case impact future tax assessments?

A3: This case sets a precedent that only the actual amount obtained should be taxed under Section 41(1), providing clarity for similar cases in the future.

The Income Tax Appellate Tribunal has referred the following questions of law to this Court, under Section 256(1) of the Income Tax Act, 1963. (for short 'the Act') relating to the assessment year 1995-96.

“1. Whether on the facts and circumstances of the case, was the Appellate Tribunal right in holding that the amount that has ceased to be a liability under section 41(1) of the Income Tax Act to be assessed as income is Rs.53,71,650/- or Rs.30,68,152/- is not a debatable issue and can be the subject matter of adjustment under sec.143(1)(a) of the Income Tax Act?

2. Whether on the facts and circumstances of the case was the Tribunal right in holding that the assessee is not entitled to deduction of the tax and interest amounting to Rs.23,03,498/- paid by the assessee from out of the gross royalty amount of Rs.53,71,650/- credited to the account of the foreign collaborator in 1990 and written back in the previous year relevant to the assessment year 1995-96?

3. Whether, on the facts and circumstances of the case should not the Tribunal have held that the cessation of liability and value of benefit that accrued to the assessee is only the differential amount of Rs.30,68,152/- which is the net amount that has accrued to the assessee after paying an amount of Rs.23,03,498/- to the Income Tax Department towards tax and interest on behalf of the foreign collaborator?”

2. The issue relates to the assessment year 1995-96. However, the sequence of events that led to the present reference has its genesis in the assessment year (for short AY) 1990-91. The assessee claimed a deduction of Rs.53,71,650/-, for the AY 1990-91 as an expenditure, being royalty payable to a foreign collaborator. Though deduction was allowed, the amount was not actually remitted outside India. In the meantime, an amount of Rs.13,65,060/- was paid towards TDS payable on the royalty amount and a further amount of Rs.9,38,438/- towards interest, as per orders issued under Section 201(1A) of the Act. Thus, a total amount of Rs.23,03,498/- was paid by the assessee towards tax and interest due to the department against the deduction claimed towards royalty payable to the foreign collaborator. In the AY 1995-96, the amount claimed as deduction for the AY 1990-91, excluding TDS and interest paid, was written back by the assessee into its accounts, on account of the cessation of liability. To state in figures, the assessee had written back Rs.30,68,152/- instead of Rs.53,71,650/-.

3. In the return filed for the AY 1995-96, assessee had thus written back only Rs.30,68,152/- under Section 41(1) of the Act. The Assessing Officer found that the entire amount of Rs.53,71,650/- ought to be treated as a deemed profit under Section 41(1)(a) of the Act and that the amount paid towards tax and interest was not liable to be deducted while returning the entry due to cessation of liability with the foreign collaborator.

4. On appeal, the First Appellate Authority held that the issue whether the entire sum of Rs.53,71,650/- or whether the said amount excluding the tax and interest paid, alone, could be regarded as a profit under Section 41(1) of the Act, was a debatable issue. It further held that since a debatable issue cannot be made the subject matter of adjustment under Section 143(1)(a), the First Appeal was allowed by deleting the addition directed by the Assessing Officer.

5. The Revenue preferred an appeal to the Tribunal. It was held by the Tribunal that the deduction claimed for tax and interest already paid was inadmissible and the appeal was allowed, thereby restoring the order of the Assessing Officer. Briefly prefaced the controversy for a decision on the points referred by the Tribunal centers around whether the assessee has to write back entry of Rs.53,71,650/- upon cessation of liability or should it be the actual amount of Rs.30,68,152/- to be written back as deemed profits under Section 41(1) of the Act for the AY 1995-96.

6. We have heard Mr. Raja Kannan, the learned counsel for the assessee as well as Sri. P.K.Raveendranatha Menon, the learned Senior Advocate for the department duly instructed by Adv. Navneeth Pai.

7. The learned counsel for the assessee submitted that the profits chargeable to tax as per Section 41(1)(a) of the Act ought to be the amount after deducting the tax and interest already paid to the department, as per the orders issued under Section 201 of the Act and not the entire amount inclusive of the tax and interest. He submitted that a contrary interpretation, if adopted, in the instant case, would cause great hardship and prejudice to the assessee including double taxation. It was also contended that when there is a doubt as to whether it is the net amount or the gross amount of the ceased liability that should be treated as the amount obtained under Section 41(1)(a) of the Act, section 143(1)(a) of the Act will have no application, as the question falls within the realm of a debatable issue. According to the learned counsel for the assessee, an issue, which is debatable or has two possible views, could not be the subject matter of a summary adjustment under Section 143(1)(a) of the Act.

8. Learned Senior Counsel for the department, on the other hand, submitted that the amount contemplated under Section 41(1)

(a) is inclusive of the tax since income tax is always levied on the amount received without deducting the tax. He further submitted that Section 41(1) is a deeming provision, which makes the amount, as contemplated under the said provision, if received by the assessee, be deemed to be the profit and gains of business and chargeable to income tax in the manner contemplated therein.

9. While considering the above controversy, it is necessary to refer to Section 41(1)(a) of the Act, which is extracted below:

“41. Profits chargeable to tax.- (1) Where an allowance or deduction has been made in the assessment for any year in respect of loss, expenditure or trading liability incurred by the assessee (hereinafter referred to as the first-mentioned person) and subsequently during any previous year.

(a) the first-mentioned person has obtained, whether in cash or in any other manner whatsoever, any amount in respect of such loss or expenditure or some benefit in respect of such trading liability by way of remission or cessation thereof, the amount obtained by such person or the value of benefit accruing to him shall be deemed to be profits and gains of business or profession and accordingly chargeable to income-tax as the income of that previous year, whether the business or profession in respect of which the allowance or deduction has been made is in existence in that year or not;”

10. A reading of the above provision indicates that a legal fiction is created to treat the amount which was once deducted as an expenditure, if received back in another assessment year, as an income from profits and gains of business. For the purpose of attracting Section 41(1), it is necessary that the following conditions are satisfied:

(i) The assessee had made an allowance or any deduction in respect of any loss, expenditure, or trading liability incurred by him.

(ii) Any amount is obtained in respect of such loss or expenditure or any benefit is obtained in respect of such trading facility by way of remission or cessation thereof; and,

(iii) Such amount or benefit is obtained by the assessee in a subsequent year.

11. Once the aforesaid conditions are satisfied, the deeming provision enacted in the closing part of Section 41(1)(a) of the Act gets attracted and the amount obtained becomes chargeable to income tax as profits and gains of business or profession. Reference to the above propositions can be derived from the decisions laid down by the Supreme Court in CIT v. Haryana Co-operative Sugar Mills Ltd. [(1985) 154 ITR 751] and Polyflex (India) Pvt. Ltd. v. CIT [(2002) 257 ITR 343].

12. A glance at the history of Section 41 will reveal the purpose behind the enactment of this provision. Section 41(1) of the 1961 Act corresponds to Section 10(2)(A) of the Income Tax Act of 1922. In the decision in British Mexican Petroleum Co. Ltd. v. Jackson (1932) 16 TC 570 (HL), it was held that once a loss or expenditure is allowed as a deduction or as a trading liability, recoupment of the loss or expenditure or remission of the trading liability would be a capital receipt and not a business receipt. By virtue of the fiction enacted under Section 41(1) of the 1963 Act, the difficulty created by the decision in British Mexican Petroleum case was overcome. The provision now by a legal fiction makes the amount so received to be treated as profits and gains includable in the total income of the assessee for the previous year in which such recoupment is obtained.

13. The purpose behind creating a fiction under Section 41(1) (a) of the Act is to tax the amount, earlier deducted but subsequently received back, to the extent recouped. It is a measure of taxing the amount recouped.

14. Though a legal fiction must be given full effect to it should not be extended beyond the purpose for which it is created. As held in Bengal Immunity Co. Ltd. v. State of Bihar (AIR 1955 SC 661) and in Maganlal v. Jaiswal Industries [(1989) 4 SCC 344], legal fictions are created only for some definite purpose and it must be limited to the purpose for which it was created and should not be extended beyond that legitimate field. Explaining the scope of legal fictions, in the decision in Vodafone International Holdings BV v. Union of India, [(2012) 6 SCC 613], it was held that the legal fiction has a limited scope and cannot be expanded by giving a purposive interpretation to the same, particularly if the result of such interpretation is to transform the concept of chargeability.

15. It is true that income tax is a portion of the profits payable to the State and the tax payable is not a permissible deduction and also that Section 198 of the Act provides that all sums deducted for the purpose of computing income of an assessee, including the tax deducted at source, shall be treated as income received. However, the aforesaid principle cannot be applied while determining the amount to be deemed as profits and gains under Section 41(1)(a) of the Act. Such an interpretation, if adopted, will in fact be expanding the fiction created and even transform the chargeability.

16. The amount deducted in 1990-91 as an expenditure consisted of an element of tax being TDS. The words employed in Section 41(1)(a) are “amount obtained by such person or the value of benefits accruing to him”. The “amount obtained” can only mean the actual amount obtained. The fiction created under the provision cannot be expanded to even include amounts that may be obtained in the future. The legal fiction is intended to deem the actual amount obtained as profits and gains from business and to tax the said actual amount.

17. Section 41(1) employs, on the one hand, words such as “allowance” or “deduction” and on the other hand “loss”, “expenditure”, or “trading liability”. These words are of general import and are understandably employed to take care of several fluid dynamics. These expressions are relatable to words used in Section 41(1)(a) i.e., “the amount obtained by such person or the value of benefit accruing to him shall be deemed to be profits, gains etc.”. Therefore an entry made in one previous year as an allowance or deduction towards “loss”, “expenditure” or “trading liability” when written back in a subsequent previous year, on account of the cessation of such liability, becomes taxable as profit or gains of business. But the tax liability should be commensurate to the actual amount received or the value of benefit accrued to the assessee in that financial year and not on the unrecovered amount or unacknowledged benefit by the assessee. The unrecovered amount becomes taxable only in the previous year when it is recovered or actually obtained.

18. The amounts paid as tax has not been obtained in 1995- 96 as the same had not been refunded. Until the amount of TDS is refunded, that amount cannot be treated as amount obtained by the assessee. The amount of TDS and interest can be deemed to be profits and gains and chargeable to tax only on refund. Until actual receipt, it is not “amount obtained” and cannot be deemed to be profits and gains from business. In other words, if it is assumed that the TDS paid by the assessee, for the royalty payable, is ordered to be refunded due to the cessation of liability and the refund is received by the assessee, the actual amount of refund when received will have to be treated as the amount obtained in the previous year of receipt and not prior to that.

19. The above concept can be illustrated as follows; if an assessee deducts Rs.10,000/- as an expenditure in 1990-91 for which Rs.1,000/- was paid as TDS. Subsequently, due to cessation of the liability, the assessee writes back Rs.9000/- in 1995-96 and applies for a refund of TDS. Refund gets ordered and is received only in 1996-97. The amount deemed to be profit under section 41(1) (a) for 1995-96 can only be Rs.9,000/- it being the actual amount received in that year. The TDS refund of Rs.1,000/-.will be the deemed profits for 1996-97. If on the other hand, the entire Rs.10,000/- in the above illustration was deemed to be profit for 1995-96, the tax refund when received becomes impossible to account for.

20. From the above, it is clear that the amount paid by the assessee as TDS comes back to the assessee only when the TDS is refunded. The amount obtained by the assessee under Section 41(1) (a) is thus the actual amount obtained.

21. Since we have held that the amount obtained under Section 41(1) shall be the actual amount obtained by the assessee exclusive of the tax paid and not refunded, the contention regarding whether the issue is a debatable one or not, does not strictly arise. However, for the purpose of complete appreciation, it is necessary to deal with the said contention also. Interpretation of the words employed in Section 41(1) required a deeper analysis and whether the section contemplates the net amount or the gross amount, was certainly a matter of debate. It cannot be held that the question raised by the assessee was a non-debatable issue. In the said circumstances, we are of the view that the First Appellate Authority was correct while the Tribunal erred in coming to the conclusion that the issue was not a debatable one.

22. In view of the above, the questions of law raised by the assessee are answered in the affirmative, i.e., against the revenue. and in favour of the assessee.

The reference is ordered accordingly.